The Latest Twists and Turns in Japan’s Economic Battle

Since the election of Shinzo Abe as Prime Minister in 2012, Japan has instituted a number of bold economic reforms (dubbed “Abenomics”) to try to jolt the country’s economy back to health after almost a quarter-century of stagnation. These reforms included increased government spending, more purchases of government bonds by the country’s central bank, deregulation, and new international trade agreements. Recently, however, Abenomics has hit a bit of a snag.

In April Japan’s consumption tax rose from 5% to 8%, a change that was agreed to in 2012 before Abe was elected. The tax increase took the air out of the Japanese economy, which contracted in both the second and third quarters of this year. The tax was scheduled to further increase to 10% next year.

Will the new efforts succeed? One of the interesting aspects about Abenomics (and a lot of economic policymaking more generally) is its somewhat circular logic: its success largely depends on how confident people are that it will succeed. If businesses believe that Abenomics will boost the economy and end Japan’s persistent deflation, for example, they’ll be more willing to raise their employees’ wages, which will help boost the economy and end deflation.

Japanese stocks surged after the central bank announced its new stimulus plan, suggesting that many investors still have faith that Abenomics can succeed. But if Japan suffers another hiccup like the recent effects of the consumption tax increase, Abenomics might not be able to recover.